Taxonomy Regulation in the EU carbon market legal framework stands for the Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088.
5 November 2020
The Regulation was published in the Official Journal on 22 June 2020 and entered into force 20 days later.
The Taxonomy Regulation establishes an EU classification system to facilitate sustainable investment.
Under the EU taxonomy, most economic activities will be screened and criteria will be determined (on the level of emissions, on recycling rates, water management requirements, etc) per activity area to determine whether it can be labelled as sustainable by investors and asset managers.
According to Article 1, the Taxonomy Regulation "establishes the criteria for determining whether an economic activity qualifies as environmentally sustainable for the purposes of establishing the degree to which an investment is environmentally sustainable".
The Taxonomy Regulation applies to:
(a) measures adopted by the EU Member States or by the European Union that set out requirements for financial market participants or issuers in respect of financial products or corporate bonds that are made available as environmentally sustainable;
(b) financial market participants that make available financial products;
(c) undertakings which are subject to the obligation to publish a non-financial statement or a consolidated non-financial statement pursuant to Article 19a or Article 29a of Directive 2013/34/EU of the European Parliament and of the Council of 26 June 2013 (on the annual financial statements, consolidated financial statements and related reports of certain types of undertakings), respectively.
The Taxonomy Regulation establishes that economic activities shall qualify as environmentally sustainable if they:
a. Make a substantial contribution to one or more of the following six environmental objectives:
i. climate change mitigation,
ii. climate change adaptation,
iii. sustainable use and protection of water and marine resources,
iv. transition to a circular economy,
v. pollution prevention and control,
vi. protection and restoration of biodiversity and ecosystems; and
b. do no significant harm (DNSH) to the other environmental objectives; and
c. meet minimum safeguards (for example, UN Guiding Principles on Business and Human Rights); and
d. comply with technical screening criteria to be established by the European Commission in delegated acts.
The technical screening criteria will address both how economic activities can be considered to make a substantial contribution to the environmental objectives and how to respect the DNSH criterion.
The Taxonomy Regulation introduces a EU-wide classification system, or "taxonomy", which will provide businesses and investors with a common scheme to identify what economic activities can be considered environmentally sustainable.
It is noteworthy, the definition of sustainable investments in Article 2(17) SFDR includes both environmental and social objectives, while the Taxonomy Regulation is only limited environmental objectives.
As the Council of the EU underlines, the taxonomy will enable investors to re-orient their investments towards more sustainable technologies and businesses.
It will be instrumental for the EU to become climate neutral by 2050 and achieve the Paris agreement's 2030 targets.
These include a 40% cut in greenhouse gas emissions for which the Commission estimates that the EU has to fill an investment gap of about 180 billion EUR per year.
Before the Taxonomy Regulation, there was no common classification system at EU or global level which defined environmentally sustainable economic activity.
FAQs, Commission Technical Expert Group on Sustainable Finance
The taxonomy is first and foremost a tool for investors.
Regulation introduces disclosure requirements, rather than telling investors in what to invest.
There is no obligation to invest only into taxonomy-compliant economic activities.
However, if a financial product is marketed and/or sold to investors as ‘environmentally sustainable’, then the extent to which it is green (the ‘greenness’) must be disclosed to investors by reference to the taxonomy.
This allows for many different investment strategies to co-exist, while avoiding a straightjacket approach.
The framework is based on six EU environmental objectives (Article 9 of the Taxonomy Regulation):
- climate change mitigation (process of holding the increase in the global average temperature to well below 2 °C and pursuing efforts to limit it to 1,5 °C above pre-industrial levels, as laid down in the Paris Agreement - Article 2(5) and Article 10 of the Taxonomy Regulation);
- climate change adaptation (process of adjustment to actual and expected climate change and its impacts (Article 2(6) and Article 11 of the Taxonomy Regulation);
- sustainable use and protection of water and marine resources (Article 12 of the Taxonomy Regulation);
- transition to a circular economy (Article 13 of the Taxonomy Regulation);
- pollution prevention and control (Article 14 of the Taxonomy Regulation); and
- protection and restauration of biodiversity and ecosystems (Article 15 of the Taxonomy Regulation).
In order to qualify as environmentally sustainable, economic activities will have to fulfil the following requirements:
1. contribute substantively to at least one of the six environmental objectives listed above;
2. not significantly harm any of the environmental objectives (Article 17 of the Taxonomy Regulation);
3. be carried out in compliance with minimum social safeguards;
4. comply with specific ‘technical screening criteria’.
The scope of the terms: "climate change mitigation" and "climate change adaptation" is explained in Recitals 24 and 25 of the Taxonomy Regulation, respectively:
"An economic activity that pursues the environmental objective of climate change mitigation should contribute substantially to the stabilisation of greenhouse gas emissions by avoiding or reducing them or by enhancing greenhouse gas removals. The economic activity should be consistent with the long-term temperature goal of the Paris Agreement. That environmental objective should be interpreted in accordance with relevant Union law, including Directive 2009/31/EC of the European Parliament and of the Council";
"An economic activity that pursues the environmental objective of climate change adaptation should contribute substantially to reducing or preventing the adverse impact of the current or expected future climate, or the risks of such adverse impact, whether on that activity itself or on people, nature or assets. That environmental objective should be interpreted in accordance with relevant Union law and the Sendai Framework for Disaster Risk Reduction 2015–2030".
Investment in coal will not be considered environmentally sustainable.
The agreement retains the concept of maintaining a neutral stance in relation to different energy forms, provided that they are low in greenhouse gas emissions.
The taxonomy will also include two sub-categories of "enabling" (Article 16 of the Taxonomy Regulation) and "transitional" activities.
There will be an obligation to disclose for each financial product the proportion invested in those enabling and transitional activities.
Remaining 4 of the 6 EU environmental objectives, i.e.sustainable use and protection of water and marine resources, transition to a circular economy, pollution prevention and control as well as protection and restauration of biodiversity and ecosystems are explained in closer detail in Recitals 26 - 31 of the Taxonomy Regulation.
The taxonomy for climate change mitigation and climate change adaptation should be established by the end of 2020, in order to ensure its full application by end of 2021.
For the four other objectives, the taxonomy should be established by the end of 2021 for an application by the end of 2022.
The document titled: “FAQs, Commission Technical Expert Group on Sustainable Finance", published on the European Commission’s website, explains (p. 6):
“Activities that are not a part of the taxonomy are not necessarily ‘polluting’: There are plenty of economic activities with very limited negative environmental impact or with only incremental contribution to environmental objectives. The taxonomy will require ‘substantial contribution’ to environmental objectives for activities to be included. Therefore, activities that do not qualify under the taxonomy are not necessarily polluting. They will simply not be categorised.”
It is further explained in the FAQ that the taxonomy will have to be used by:
- the EU Member States for the purposes of any measures setting out requirements on market actors in respect of financial products or corporate bonds that are marketed or deemed as environmentally sustainable,
- financial market participants offering financial products as environmentally sustainable investments or investments having similar characteristics (they would have to disclose information on how the criteria for environmentally sustainable economic activities are used to determine the environmental sustainability of the investment).
The taxonomy is not and will not be a mandatory list of activities in which to invest.
Market-led labels can continue to exist and funds targeting environmental objectives are not limited to investing in taxonomy-compliant activities – they just need to be clear on whether and to what extent their green products finance activities that qualify under the taxonomy.
In addition, the taxonomy can also be used on a voluntary basis by any financial institution.
For example, banks could potentially use it as a basis for their lending activities.
The taxonomy should moreover encourage companies to raise funds for projects that meet the criteria of the taxonomy, or to show the percentage of revenue or turnover from green activities with reference to the taxonomy, in order to raise green funding.
The specific uses of the taxonomy have been explained in the FAQ document (p. 9) as follows:
1. as regards financial assets (loans, bonds, equity):
- assets that are used to finance only the environmentally sustainable activities of the company (e.g. "green bonds" with transparent use of proceeds for environmentally beneficial purposes) could be considered environmentally sustainable, while other assets that only partially finance green activities may have various degrees of environmental sustainability;
- the degree of environmental sustainability can similarly be determined for investment portfolios consisting of several companies, which will incentivise investments into environmentally sustainable economic activities, without penalising or creating disincentives for investments into other economic activities;
2. as regards financial products (i.e. funds) and investment strategies:
- as the taxonomy provides a tool to assess the degree to which financial assets or companies contribute substantially to environmental objectives, it also allows financial market participants to use the taxonomy as a factor for selecting their investments;
- what’s important, it does not prescribe such strategy and allows for different degrees of ‘greenness’ and for different investment strategies currently existing in the market, such as those purely based on exclusion criteria.
The said FAQ document also mentions that the European Commission is looking into the development of an EU Ecolabel for financial products, which will consider the issue of how the taxonomy links to financial products, and therefore indirectly how it links to financial assets and companies.
Platform on Sustainable Finance
The Taxonomy Regulation foresees the establishment of a Platform on Sustainable Finance (Article 20).
Among the tasks of this platform will be to review the thresholds by taking into account technological changes and to advise the European Commission on the need to update the taxonomy by including or excluding certain activities.
However, as the said FAQ document explains (p.7), this process should not lead to uncertainty or liability risks for investors.
Financial market participants who feel that a certain activity should be considered as environmentally sustainable for investment purposes should inform the Commission by submitting scientific evidence for their suggestion.
This feedback will help the Commission and the Sustainable Finance Platform to evaluate the appropriateness of complementing or updating the taxonomy.
In is also stressed that some of the technical criteria proposed may take the form of dynamic thresholds that are tightened over time in order to meet the increasingly ambitious objectives in a gradual way.
This is intended to be an approach that allows for dynamism but also provides for certainty upfront as the path of tightening can be determined when establishing the thresholds.
Technical screening criteria
Requirements for technical screening criteria are laid down in Article 19 of the Taxonomy Regulation.
In particular, they must ensure "that power generation activities that use solid fossil fuels do not qualify as environmentally sustainable economic activities" (paragraph 3).
Publication requirements on non-financial undertakings under the the Non-Financial Reporting Directive
Article 8 of the Taxonomy Regulation obliges undertakings covered by Directive 2014/95/EU (the Non-Financial Reporting Directive) to publish information on how and to what extent their activities are associated with economic activities that qualify as environmentally sustainable under the Taxonomy Regulation.
For this purpose, Article 8(2) requires non-financial undertakings to use three key performance indicators (‘KPIs’), namely the proportion of their turnover, their capital expenditure (‘CapEx’) and their operating expenditure (‘OpEx’) related to environmentally sustainable activities.
Article 8 does not specify any KPIs to be used by financial undertakings.
Article 8(4) of the Taxonomy Regulation requires the European Commission to adopt a delegated act to supplement the above obligations by specifying the content, presentation and methodology of the information to be disclosed by both financial and non-financial undertakings subject to the Non-Financial Reporting Directive.
The Commission has to adopt the delegated act by 1 June 2021.
Taxonomy Regulation, Article 8
Transparency of undertakings in non-financial statements
1. Any undertaking which is subject to an obligation to publish non-financial information pursuant to Article 19a or Article 29a of Directive 2013/34/EU shall include in its non-financial statement or consolidated non-financial statement information on how and to what extent the undertaking’s activities are associated with economic activities that qualify as environmentally sustainable under Articles 3 and 9 of this Regulation.
2. In particular, non-financial undertakings shall disclose the following:
(a) the proportion of their turnover derived from products or services associated with economic activities that qualify as environmentally sustainable under Articles 3 and 9; and
(b) the proportion of their capital expenditure and the proportion of their operating expenditure related to assets or processes associated with economic activities that qualify as environmentally sustainable under Articles 3 and 9.
3. If an undertaking publishes non-financial information pursuant to Article 19a or Article 29a of Directive 2013/34/EU in a separate report in accordance with Article 19a(4) or Article 29a(4) of that Directive, the information referred to in paragraphs 1 and 2 of this Article shall be published in that separate report.
4. The Commission shall adopt a delegated act in accordance with Article 23 to supplement paragraphs 1 and 2 of this Article to specify the content and presentation of the information to be disclosed pursuant to those paragraphs, including the methodology to be used in order to comply with them, taking into account the specificities of both financial and non-financial undertakings and the technical screening criteria established pursuant to this Regulation. The Commission shall adopt that delegated act by 1 June 2021.
5 November 2020
22 June 2020
Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088 published in the Official Journal of the EU
Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088 (Taxonomy Regulation)